Sunday, November 13, 2011

Stimulus -- What? Another One? (Part Two -- The Reckoning)

Yesterday, we fielded a couple of questions from the Ochreous Man on the need for a second stimulus. One question, about the "job creators," we answered. The second we'll be tackling today.

Now – did the original stimulus fail?

Well, if you ask Douglas Holtz-Eakin, it sure did.

And who is Doug H-E? Well, he is a “former Congressional Budget Office director, former chief economic advisor to Sen. John McCain’s 2008 presidential campaign, and current president of the conservative American Action Forum.” In short, a pretty conservative dude.  And he made a splash when he created this graph to show that the stimulus didn’t work.

Holtz-Eakin said that:

The chart … shows actual GDP during 2009. It also shows what would have happened if the trajectory at the start of 2009 had continued the entire year (labeled “Continued Decline”) -- that is, the graphical version of “the economy was falling off a cliff.” The shaded area is the difference—the additional GDP from not continuing to decline—and totals $268 billion.

Stimulus tax cuts and spending in 2009 were roughly $260 billion. Thus, if one attributes all improvement in GDP to the stimulus—no role for the Fed, no role for mortgage relief programs, no role for worldwide economic improvement—then stimulus essentially broke even and provided no multiplier effects.

A key point here. Doug is NOT saying that the stimulus had no effect; he’s saying it had no multiplier effect. He does acknowledge that the $260 billion in stimulus had an effect, but that the effect was limited to $268 billion. So in no way should the stimulus be considered wasted money. As Doug says, the “stimulus essentially broke even.”

But Keynesians argued that the stimulus would have had a greater effect. In our sandwich shop example from yesterday, the stimulus was the new employer in town, but the multiplier effect – the spending of the new employees – had a multiplier effect which resulted in the hiring of an additional employee. And Holtz-Eakins said that didn’t happen.

Unfortunately for Doug H-E Fresh, he was working off of bad numbers. Those numbers were the best information at the time, but the Bureau of Economic Analysis revised those numbers in July of this year, and it showed that the economic situation was much, much worse.  An updated chart shows that the shaded area – “the additional GDP from not continuing to decline” – was more like $544 billion (not $268 billion).

The $260 billion in stimulus then had a multiplier effect of around 2.1, meaning that every $1 spent resulted in $2.10 in additional GDP.

Remember here that the methodology is unchanged. It’s the one recommended by a very prominent conservative economist. The only thing that has changed is the numbers getting plugged into that methodology. And those numbers show that the economy going into 2009 was not sliding into a recession – it was in free-fall.

In the second quarter of 2008, the economy grew by an annualized rate of just 1.3 percent. In the following quarter it contracted by 3.7 percent, and then by a whopping 8.9 percent in the last quarter of 2008 as President George W. Bush prepared to hand over the White House reins to President Obama.

By comparison, the original figures for the third and fourth quarters of 2008 were -0.5% and -3.8%. So the economy was cratering at more than twice the rate we thought it was.  That's huge.

So ...

if instead of assuming the economy would have contracted in each successive quarter at the same rate as it had in the fourth quarter of 2008, we assume that it continued dropping but at an increasing rate, as it had been during the last three quarters of 2008, then the success of the stimulus is even more pronounced, with a multiplier surpassing 5.

The first stimulus worked. It was just too small – just as Paul Krugman predicted shortly after the stimulus package was introduced. Now, Krugman gets called a lot of names, but we like him and, in this instance, he was demonstrably right.

But that’s not always the case. He also thought that a second stimulus would follow sometime later in 2009, and on that he was dead wrong.

Which is why, sadly, and two full years later, we have to do it now.

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